The “Old Economy” strikes back

17 maggio 2018

Salman Ahmed, PhD

Chief Investment Strategist

Oil prices are currently subject to spike risk. As geopolitical risk continues to build in the Middle East and supply-side dynamics remain relatively constrained, we believe the oil price could rise significantly in the coming weeks as the “Old Economy” strikes back.

As the US continues on its path of unilateralism, pulling out of the Iran nuclear deal in early May, a new World Order is emerging. The unconditional post-World War II alliances that have worked as a stabilising influence in the Middle East for the last 70 years, are being replaced by more issues-led relationships, leaving the region with a weakened safety net.

With the US also now significantly less reliant on the rest of the world for its fossil fuel supplies, thanks largely to the development of the domestic shale market, the US incentive to maintain ongoing stability in the Middle East is reduced.

However, the excess inventories resulting from the rise in shale contributed to a closer cooperation between OPEC and Russia, which has since been quite successful in cleaning up that over supply. As such, the geopolitical tensions in the Middle East come at a time when market balances are already quite tight.

Given the sharp fall in Venezuelan production and structural issues holding back the adjustment in US supply, what happens with Iranian oil will be key, in our view.

We believe geopolitical conditions, rather than a stronger global economy, will now be shaping oil as a risk factor.

Investment implications

Correlations between Brent and other asset classes have shifted significantly

Russia’s underperformance versus other emerging markets may be reversed

Energy equities, given their low valuations, stand to benefit, in our view

A rise in the oil price adds to inflationary pressure, keeping upside pressure on US yields

More broadly, we believe rising geopolitical tension is likely to weigh on risk sentiment, although risky assets are likely to remain supported by ongoing business cycle dynamics

important information.

For professional investor use only.This document is issued by Lombard Odier Asset Management (Europe) Limited, authorised and regulated by the Financial Conduct Authority (the “FCA”), and entered on the FCA register with registration number 515393.
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